A cigarette smuggling epidemic is coming to DC

A cigarette smuggling epidemic is coming to DC
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As a component of Washington, D.C.’s most recent city budget, the district will raise its cigarette excise tax from $2.50 per pack to $4.50 next month. This development is notable not only because it means the tax will increase by 80 percent in just one year, but also because D.C. will have one of the highest state cigarette taxes in the country after the increase is in place Oct. 1.

Cigarette taxes are seen as a way to encourage people to kick a smoking habit. But in part because of the district’s small geographical area (just 68 square miles), and in part because of significantly lower cigarette taxes in nearby states, what this tax increase is more likely to do is to intensify cross-border shopping and illegal smuggling.

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District residents and commuters already have an incentive to shop elsewhere for their tobacco products. Maryland taxes its cigarettes at $2 per pack and Virginia does so at just 30 cents. It will be all too easy for workers living in Maryland and Virginia and for district residents to take a short, inexpensive train or car ride to a nearby border.

While this cross-border shopping will reduce the tax increase’s ability to bring in stable revenue, more worrisome to district officials is how this tax differential will likely lead to a black market and organized smuggling.

Through theory and practice, we know this to be true from years of study. We are economists who, along with Ball State University professor Todd Nesbit, annually estimate the degree to which cigarettes are trafficked into and out of the 48 contiguous United States.

We found, for instance, that through 2016, almost 56 percent of all cigarettes consumed in New York state were procured through tax avoidance and evasion. New York state taxes cigarettes at $4.35 per pack and New York City adds another $1.50.

Our studies do not attempt to measure illicit activity in the district, but we have reviewed scholarly literature that does. For example, Professor Michael Lovenheim’s award-winning 2008 paper, published in the National Tax Journal and titled, “How Far to the Border: The Extent and Impact of Cross-Border Casual Cigarette Smuggling,” made an estimate that 63 percent of consumers smuggle their cigarettes into the district. That figure was calculated using consumption data from as late as 2002. In November 2001, according to Lovenheim, the tax differential between the district and Virginia was just 73 cents.

A 2013 study published in the journal Tobacco Control measured the smuggling phenomenon by examining the tax stamps of discarded cigarette packages in the district. A tax stamp indicates the origin of the product. The researchers found that 81.4 percent of the packs they collected had a known but nonlocal stamp, a foreign or unknown stamp, or no stamp at all, suggesting widespread cross-border tax evasion and avoidance. Of the total packs examined, half came from Virginia. Another one-third came from Maryland.

This study was performed when the district’s excise tax was $2.50 and the tax differential with Virginia was $2.20. Raising the excise tax another $2 per pack will create a yawning tax gap of $4.20. With a large portion of the district’s population living under four miles from Virginia, it doesn’t strain credulity to suggest that legal cigarette purchases will plummet once again, and probably with little, if any improvement, in health outcomes.

In practice on the ground, organized cigarette smuggling has been associated with everything from government corruption to murder-for-hire plots to violence against people, police and property.

One of us (Drenkard) testified before the D.C. Council Committee on Finance and Revenue as this tax increase was being considered in February. In his testimony he warned that this increase is not only regressive and will hurt the poor the most, but it will claw back a significant part of the positive tax reforms enacted by the D.C. Council in 2014.

Policymakers in the 50 states should watch this cigarette tax hike with scrutiny. It hurts the district’s overall tax makeup, it opens the door to organized crime, it is unlikely to achieve its stated health goals, and it might even generate less revenue.

Michael LaFaive is senior director of fiscal policy for the Mackinac Center for Public Policy and author of “Prohibition by Price: Cigarette Taxes and Unintended Consequences,” a chapter from the book, “For Your Own Good.”

Scott Drenkard is an economist and director of state projects with the Washington, D.C.-based Tax Foundation.